Chip crunch

Merrill cuts semiconductor stocks in valuation call

By

SusanLerner

NEW YORK (CBS.MW) -- Semiconductor stocks took a beating Thursday following downgrades from Merrill Lynch even as the broker maintained a much more favorable view of the semiconductor capital-equipment group.

Most notable among the firm's cuts was a downgrade of the world's largest chipmaker, Intel, which analyst Joe Osha sliced to "intermediate-term neutral" from "intermediate-term strong buy" just as the company gets set to provide Wall Street with its mid-quarter update after the closing bell. See full story.

Intel
INTC, -0.78%
shares finished the day down $1.18, or 4.2 percent, at $27.

Osha said that with Intel's April and May results coming in weak, he expects the company to tighten its second-quarter outlook with a slight bias toward the lower end of the earlier $6.4 billion to $7 billion target to perhaps $6.5 billion to $6.8 billion.

"With one month remaining and few signs of a near-term PC upgrade cycle, the prospects for sequential growth in the June quarter are quickly fading," said Osha, who warned clients that with the second quarter becoming increasingly back-end loaded "much is still to be determined."

Analysts have been weighing in with their guesses on what Intel will say in its update for weeks. But while some had lowered estimates for Intel, none had downgraded the stock. Indeed, just a week ago, Osha had cut his estimates while reiterating the "strong buy" rating he had placed on the stock at the end of January when the stock was trading about 20 percent above Wednesday's close.

On May 28, Osha, who is now forecasting revenues of $6.76 billion and earnings of 17 cents a share for the second quarter, told clients he expected the stock to "trade well" through what he thought would be a seasonally strong June, adding that he believed "Intel has left itself a lot of gross margin headroom later in the year."

Osha could not be reached for further comment on what exactly had changed in the last week to prompt the downgrade now. The stock price when he made those comments was $29.39, still above Wednesday's $28.18 close.

Looking at the sector as a whole, Osha said it was time to come to terms with high valuations.

"Unfortunately, we believe revenue and earnings estimates already reflect any reasonable recovery expectation," he said. "The likelihood of a stronger recovery has been evaporating as the year has progressed."

Osha said it is becoming apparent that the semiconductor business has been benefiting mostly from easy comparisons and low inventory and he believes the early cycle semiconductor upturn has now played itself out.

Though he acknowledges that it's possible and even likely that chip stocks may rally again in June as the PC business accelerates seasonally, he doubts there is an underpinning for a more sustained positive move. "We don't like the odds of making money during the next three quarters on these valuations," he said.

Also getting the ax from Osha Thursday were Linear Technology
LLTC
Semtech
SMTC, -1.94%
Texas Instruments
TXN, -0.10%
and Triquint
TQNT
which had their intermediate-term recommendations slashed to "neutral," and Analog Devices
ADI, +0.81%
and Maxim Integrated Products
MXIM, +0.08%
which were cut to "intermediate-term buy."

However, Osha continues to favor some foreign names, which he believes are well-positioned and more attractively valued than their U.S. counterparts. He continues to like ST Microelectronics
STM, -1.63%
Taiwan Semiconductor
TSM, -0.09%
United Microelectronics
UMC, +0.00%
and Samsung Electronics.

Meanwhile, Osha's colleague at Merrill, Brett Hodess, on Thursday was calling the chip equipment group attractively valued. Chips are the actual components that run a computer whereas semiconductor capital equipment makers produce the equipment that manufactures the chips.

Hodess told clients the group has been weak recently on investor concerns about the sustainability of recent order momentum in light of less than robust end market demand. However, he thinks any weakness in the stocks provides an attractive entry point.

"We are beginning to hear that orders are broadening to other second tier players and we believe that these will be the growth driver in the second half," Hodess said, noting that foundries had been the key drivers of orders so far this year. And, Hodess believes technology upgrades will continue to drive order growth.

Hodess said his favorite companies are those that are in technology niches and are leveraged to new technology, or materials companies including Photon Dynamics
PHTN
Novellus
NVLS
Photronics
PLAB, -4.32%
and Entegris
ENTG, -0.15%

Of those, all were lower except for Photon Dynamics, which rose $1.15, or 3.3 percent, to finish the day at $36.25.

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